International Standard on Auditing (Ireland) 315

Identifying and Assessing the Risks of Material

Misstatement Through Understanding the Entity and its Environment

MISSION To contribute to Ireland having a strong regulatory environment in which to do

business by supervising and promoting high quality financial reporting, auditing and effective regulation of the accounting profession in the public

interest

© This publication contains copyright material of both the International Federation of Accountants and the Financial Reporting Council Limited. All rights reserved.

Reproduced and modified by the Irish Auditing and Accounting Supervisory Authority with the permission of the International Federation of Accountants and the Financial

Reporting Council Limited. No permission granted to third parties to reproduce or distribute.

INTERNATIONAL STANDARD ON AUDITING (IRELAND) 315

IDENTIFYING AND ASSESSING THE RISKS OF MATERIAL MISSTATEMENT THROUGH UNDERSTANDING THE ENTITY AND

ITS ENVIRONMENT

(Effective for the audits of financial statements for periods commencing on or after 17 June

2016, for which opinions are issued on or after 1 February 2017)

CONTENTS

Paragraph

Introduction

Scope of this ISA (Ireland) ............................................................................. 1

Effective Date ................................................................................................. 2

Objective ....................................................................................................... 3

Definitions .................................................................................................... 4

Requirements

Risk Assessment Procedures and Related Activities ......................................... 5–10

The Required Understanding of the Entity and Its Environment,

Including the Entity’s Internal Control ......................................................... 11–24

Identifying and Assessing the Risks of Material Misstatement ........................ 25–31

Documentation ............................................................................................... 32

Application and Other Explanatory Material

Risk Assessment Procedures and Related Activities ...................................... A1–A23

The Required Understanding of the Entity and Its Environment,

Including the Entity’s Internal Control ......................................................... A24–A117

Identifying and Assessing the Risks of Material Misstatement ........................ A118–A143

Documentation ............................................................................................... A144–A147

Appendix 1: Internal Control Components

Appendix 2: Conditions and Events That May Indicate Risks of Material Misstatement

International Standard on Auditing (Ireland) (ISA (Ireland)) 315, Identifying and Assessing

the Risks of Material Misstatement through Understanding the Entity and Its Environment

should be read in conjunction with ISA (Ireland) 200, Overall Objectives of the

Independent Auditor and the Conduct of an Audit in Accordance with International

Standards on Auditing (Ireland).

ISA (Ireland) 315

1

Introduction

Scope of this ISA (Ireland)

1. This International Standard on Auditing (Ireland) (ISA (Ireland)) deals with the

auditor’s responsibility to identify and assess the risks of material misstatement in the

financial statements, through understanding the entity and its environment, including

the entity’s internal control.

Effective Date

2. This ISA (Ireland) is effective for the audits of financial statements for periods

commencing on or after 17 June 2016, for which opinions are issued on or after 1

February 2017.

Objective

3. The objective of the auditor is to identify and assess the risks of material

misstatement, whether due to fraud or error, at the financial statement and assertion

levels, through understanding the entity and its environment, including the entity’s

internal control, thereby providing a basis for designing and implementing responses

to the assessed risks of material misstatement.

Definitions

4. For purposes of the ISAs (Ireland), the following terms have the meanings attributed

below:

(a) Assertions – Representations by management1a, explicit or otherwise, that are

embodied in the financial statements, as used by the auditor to consider the

different types of potential misstatements that may occur.

(b) Business risk – A risk resulting from significant conditions, events,

circumstances, actions or inactions that could adversely affect an entity’s ability

to achieve its objectives and execute its strategies, or from the setting of

inappropriate objectives and strategies.

(c) Internal control – The process designed, implemented and maintained by those

charged with governance, management and other personnel to provide

reasonable assurance about the achievement of an entity’s objectives with

regard to reliability of financial reporting, effectiveness and efficiency of

operations, and compliance with applicable laws and regulations. The term

“controls” refers to any aspects of one or more of the components of internal

control.

(d) Risk assessment procedures – The audit procedures performed to obtain an

understanding of the entity and its environment, including the entity’s internal

control, to identify and assess the risks of material misstatement, whether due to

fraud or error, at the financial statement and assertion levels.

(e) Significant risk – An identified and assessed risk of material misstatement that,

in the auditor’s judgment, requires special audit consideration.

1a

Those charged with governance are responsible for preparing the financial statements.

ISA (Ireland) 315

2

Requirements

Risk Assessment Procedures and Related Activities

5. The auditor shall perform risk assessment procedures to provide a basis for the

identification and assessment of risks of material misstatement at the financial

statement and assertion levels. Risk assessment procedures by themselves,

however, do not provide sufficient appropriate audit evidence on which to base the

audit opinion. (Ref: Para. A1-A5)

6. The risk assessment procedures shall include the following:

(a) Inquiries of management, of appropriate individuals within the internal audit

function (if the function exists), and of others within the entity who in the

auditor’s judgment may have information that is likely to assist in identifying

risks of material misstatement due to fraud or error. (Ref: Para. A6-A13)

(b) Analytical procedures. (Ref: Para. A14-A17)

(c) Observation and inspection. (Ref: Para. A18)

7. The auditor shall consider whether information obtained from the auditor’s client

acceptance or continuance process is relevant to identifying risks of material

misstatement.

8. If the engagement partner has performed other engagements for the entity, the

engagement partner shall consider whether information obtained is relevant to

identifying risks of material misstatement.

9. Where the auditor intends to use information obtained from the auditor’s previous

experience with the entity and from audit procedures performed in previous audits,

the auditor shall determine whether changes have occurred since the previous audit

that may affect its relevance to the current audit. (Ref: Para. A19-A20)

10. The engagement partner and other key engagement team members shall discuss the

susceptibility of the entity’s financial statements to material misstatement, and the

application of the applicable financial reporting framework to the entity’s facts and

circumstances. The engagement partner shall determine which matters are to be

communicated to engagement team members not involved in the discussion. (Ref:

Para. A21-A23)

The Required Understanding of the Entity and Its Environment, Including the

Entity’s Internal Control

The Entity and Its Environment

11. The auditor shall obtain an understanding of the following:

(a) Relevant industry, regulatory, and other external factors including the

applicable financial reporting framework. (Ref: Para. A24-A29)

(b) The nature of the entity, including:

(i) its operations;

(ii) its ownership and governance structures;

(iii) the types of investments that the entity is making and plans to make,

including investments in special-purpose entities; and

ISA (Ireland) 315

3

(iv) the way that the entity is structured and how it is financed

to enable the auditor to understand the classes of transactions, account

balances, and disclosures to be expected in the financial statements. (Ref: Para.

A30-A34)

(c) The entity’s selection and application of accounting policies, including the

reasons for changes thereto. The auditor shall evaluate whether the entity’s

accounting policies are appropriate for its business and consistent with the

applicable financial reporting framework and accounting policies used in the

relevant industry. (Ref: Para. A35)

(d) The entity’s objectives and strategies, and those related business risks that

may result in risks of material misstatement. (Ref: Para. A36-A42)

(e) The measurement and review of the entity’s financial performance. (Ref: Para.

A43-A48)

The Entity’s Internal Control

12. The auditor shall obtain an understanding of internal control relevant to the audit.

Although most controls relevant to the audit are likely to relate to financial reporting,

not all controls that relate to financial reporting are relevant to the audit. It is a matter

of the auditor’s professional judgment whether a control, individually or in

combination with others, is relevant to the audit. (Ref: Para. A49-A72)

Nature and Extent of the Understanding of Relevant Controls

13. When obtaining an understanding of controls that are relevant to the audit, the

auditor shall evaluate the design of those controls and determine whether they have

been implemented, by performing procedures in addition to inquiry of the entity’s

personnel. (Ref: Para. A73-A75)

Components of Internal Control

Control environment

14. The auditor shall obtain an understanding of the control environment. As part of

obtaining this understanding, the auditor shall evaluate whether:

(a) Management, with the oversight of those charged with governance, has created

and maintained a culture of honesty and ethical behavior; and

(b) The strengths in the control environment elements collectively provide an

appropriate foundation for the other components of internal control, and

whether those other components are not undermined by deficiencies in the

control environment. (Ref: Para. A76-A86)

The entity’s risk assessment process

15. The auditor shall obtain an understanding of whether the entity has a process for:

(a) Identifying business risks relevant to financial reporting objectives;

(b) Estimating the significance of the risks;

(c) Assessing the likelihood of their occurrence; and

(d) Deciding about actions to address those risks. (Ref: Para. A87)

ISA (Ireland) 315

4

16. If the entity has established such a process (referred to hereafter as the “entity’s risk

assessment process”), the auditor shall obtain an understanding of it, and the results

thereof. If the auditor identifies risks of material misstatement that management failed

to identify, the auditor shall evaluate whether there was an underlying risk of a kind

that the auditor expects would have been identified by the entity’s risk assessment

process. If there is such a risk, the auditor shall obtain an understanding of why that

process failed to identify it, and evaluate whether the process is appropriate to its

circumstances or determine if there is a significant deficiency in internal control with

regard to the entity’s risk assessment process.

17. If the entity has not established such a process or has an ad hoc process, the auditor

shall discuss with management whether business risks relevant to financial reporting

objectives have been identified and how they have been addressed. The auditor shall

evaluate whether the absence of a documented risk assessment process is

appropriate in the circumstances, or determine whether it represents a significant

deficiency in internal control. (Ref: Para. A88)

The information system, including the related business processes, relevant to financial

reporting, and communication

18. The auditor shall obtain an understanding of the information system, including the

related business processes, relevant to financial reporting, including the following

areas: (Ref: Para. A89–A89a)

(a) The classes of transactions in the entity’s operations that are significant to the

financial statements;

(b) The procedures, within both information technology (IT) and manual systems,

by which those transactions are initiated, recorded, processed, corrected as

necessary, transferred to the general ledger and reported in the financial

statements;

(c) The related accounting records, supporting information and specific accounts in

the financial statements that are used to initiate, record, process and report

transactions; this includes the correction of incorrect information and how

information is transferred to the general ledger. The records may be in either

manual or electronic form;

(d) How the information system captures events and conditions, other than

transactions, that are significant to the financial statements;

(e) The financial reporting process used to prepare the entity’s financial

statements, including significant accounting estimates and disclosures; and

(f) Controls surrounding journal entries, including non-standard journal entries

used to record non-recurring, unusual transactions or adjustments. (Ref: Para.

A89-A93)

This understanding of the information system relevant to financial reporting shall

include relevant aspects of that system relating to information disclosed in the

financial statements that is obtained from within or outside of the general and

subsidiary ledgers.

ISA (Ireland) 315

5

19. The auditor shall obtain an understanding of how the entity communicates financial

reporting roles and responsibilities and significant matters relating to financial

reporting, including: (Ref: Para. A94-A95)

(a) Communications between management and those charged with governance;

and

(b) External communications, such as those with regulatory authorities.

Control activities relevant to the audit

20. The auditor shall obtain an understanding of control activities relevant to the audit,

being those the auditor judges it necessary to understand in order to assess the risks

of material misstatement at the assertion level and design further audit procedures

responsive to assessed risks. An audit does not require an understanding of all the

control activities related to each significant class of transactions, account balance,

and disclosure in the financial statements or to every assertion relevant to them. (Ref:

Para. A96-A102)

21. In understanding the entity’s control activities, the auditor shall obtain an

understanding of how the entity has responded to risks arising from IT. (Ref: Para.

A103-A105)

Monitoring of controls

22. The auditor shall obtain an understanding of the major activities that the entity uses

to monitor internal control relevant to financial reporting, including those related to

those control activities relevant to the audit, and how the entity initiates remedial

actions to deficiencies in its controls. (Ref: Para. A106-A108)

23. If the entity has an internal audit function,1 the auditor shall obtain an understanding

of the nature of the internal audit function’s responsibilities, its organizational status,

and the activities performed, or to be performed. (Ref: Para A109-A116)

24. The auditor shall obtain an understanding of the sources of the information used in

the entity’s monitoring activities, and the basis upon which management considers

the information to be sufficiently reliable for the purpose. (Ref: Para. A117)

Identifying and Assessing the Risks of Material Misstatement

25. The auditor shall identify and assess the risks of material misstatement at:

(a) the financial statement level; and (Ref: Para. A118-A121)

(b) the assertion level for classes of transactions, account balances, and

disclosures (Ref: Para. A122-A126)

to provide a basis for designing and performing further audit procedures.

26. For this purpose, the auditor shall:

(a) Identify risks throughout the process of obtaining an understanding of the entity

and its environment, including relevant controls that relate to the risks, and by

considering the classes of transactions, account balances, and disclosures

(including the quantitative or qualitative aspects of such disclosures) in the

financial statements; (Ref: Para. A127-A128b)

1 ISA (Ireland) 610, Using the Work of Internal Auditors, paragraph 14, defines the term “internal

audit function” for purposes of the ISAs (Ireland).

ISA (Ireland) 315

6

(b) Assess the identified risks, and evaluate whether they relate more pervasively

to the financial statements as a whole and potentially affect many assertions;

(c) Relate the identified risks to what can go wrong at the assertion level, taking

account of relevant controls that the auditor intends to test; and (Ref: Para. A129-

A131)

(d) Consider the likelihood of misstatement, including the possibility of multiple

misstatements, and whether the potential misstatement could result in a

material misstatement. (Ref: Para. A131a)

Risks That Require Special Audit Consideration

27. As part of the risk assessment as described in paragraph 25, the auditor shall

determine whether any of the risks identified are, in the auditor’s judgment, a

significant risk. In exercising this judgment, the auditor shall exclude the effects of

identified controls related to the risk.

28. In exercising judgment as to which risks are significant risks, the auditor shall

consider at least the following:

(a) Whether the risk is a risk of fraud;

(b) Whether the risk is related to recent significant economic, accounting or other

developments and, therefore, requires specific attention;

(c) The complexity of transactions;

(d) Whether the risk involves significant transactions with related parties;

(e) The degree of subjectivity in the measurement of financial information related to

the risk, especially those measurements involving a wide range of

measurement uncertainty; and

(f) Whether the risk involves significant transactions that are outside the normal

course of business for the entity, or that otherwise appear to be unusual. (Ref:

Para. A132-A136)

29. If the auditor has determined that a significant risk exists, the auditor shall obtain an

understanding of the entity’s controls, including control activities, relevant to that risk.

(Ref: Para. A137-A139)

Risks for Which Substantive Procedures Alone Do Not Provide Sufficient Appropriate

Audit Evidence

30. In respect of some risks, the auditor may judge that it is not possible or practicable to

obtain sufficient appropriate audit evidence only from substantive procedures. Such

risks may relate to the inaccurate or incomplete recording of routine and significant

classes of transactions or account balances, the characteristics of which often permit

highly automated processing with little or no manual intervention. In such cases, the

entity’s controls over such risks are relevant to the audit and the auditor shall obtain

an understanding of them. (Ref: Para. A140-A142)

Revision of Risk Assessment

31. The auditor’s assessment of the risks of material misstatement at the assertion level

may change during the course of the audit as additional audit evidence is obtained.

In circumstances where the auditor obtains audit evidence from performing further

audit procedures, or if new information is obtained, either of which is inconsistent with

ISA (Ireland) 315

7

the audit evidence on which the auditor originally based the assessment, the auditor

shall revise the assessment and modify the further planned audit procedures

accordingly. (Ref: Para. A143)

Documentation

32. The auditor shall include in the audit documentation:2

(a) The discussion among the engagement team where required by paragraph 10,

and the significant decisions reached;

(b) Key elements of the understanding obtained regarding each of the aspects of

the entity and its environment specified in paragraph 11 and of each of the

internal control components specified in paragraphs 14-24; the sources of

information from which the understanding was obtained; and the risk

assessment procedures performed;

(c) The identified and assessed risks of material misstatement at the financial

statement level and at the assertion level as required by paragraph 25; and

(d) The risks identified, and related controls about which the auditor has obtained

an understanding, as a result of the requirements in paragraphs 27-30. (Ref:

Para. A144-A147)

***

Application and Other Explanatory Material

Risk Assessment Procedures and Related Activities (Ref: Para. 5)

A1. Obtaining an understanding of the entity and its environment, including the entity’s

internal control (referred to hereafter as an “understanding of the entity”), is a

continuous, dynamic process of gathering, updating and analyzing information

throughout the audit. The understanding establishes a frame of reference within

which the auditor plans the audit and exercises professional judgment throughout the

audit, for example, when:

Assessing risks of material misstatement of the financial statements;

Determining materiality in accordance with ISA (Ireland) 320;3

Considering the appropriateness of the selection and application of accounting

policies, and the adequacy of financial statement disclosures;

Identifying areas relating to amounts or disclosures in the financial statements

where special audit consideration may be necessary, for example, related party

transactions or management’s assessment of the entity’s ability to continue as

a going concern, or when considering the business purpose of transactions;

Developing expectations for use when performing analytical procedures;

Responding to the assessed risks of material misstatement, including designing

and performing further audit procedures to obtain sufficient appropriate audit

evidence; and

2 ISA (Ireland) 230, Audit Documentation, paragraphs 8-11, and A6.

3 ISA (Ireland) 320, Materiality in Planning and Performing an Audit.

ISA (Ireland) 315

8

Evaluating the sufficiency and appropriateness of audit evidence obtained, such

as the appropriateness of assumptions and of management’s3a oral and written

representations.

A2. Information obtained by performing risk assessment procedures and related activities

may be used by the auditor as audit evidence to support assessments of the risks of

material misstatement. In addition, the auditor may obtain audit evidence about

classes of transactions, account balances, or disclosures and related assertions and

about the operating effectiveness of controls, even though such procedures were not

specifically planned as substantive procedures or as tests of controls. The auditor

also may choose to perform substantive procedures or tests of controls concurrently

with risk assessment procedures because it is efficient to do so.

A3. The auditor uses professional judgment to determine the extent of the understanding

required. The auditor’s primary consideration is whether the understanding that has

been obtained is sufficient to meet the objective stated in this ISA (Ireland). The

depth of the overall understanding that is required by the auditor is less than that

possessed by management in managing the entity.

A4. The risks to be assessed include both those due to error and those due to fraud, and

both are covered by this ISA (Ireland). However, the significance of fraud is such that

further requirements and guidance are included in ISA (Ireland) 240 in relation to risk

assessment procedures and related activities to obtain information that is used to

identify the risks of material misstatement due to fraud.4

A5. Although the auditor is required to perform all the risk assessment procedures

described in paragraph 6 in the course of obtaining the required understanding of the

entity (see paragraphs 11-24), the auditor is not required to perform all of them for

each aspect of that understanding. Other procedures may be performed where the

information to be obtained there from may be helpful in identifying risks of material

misstatement. Examples of such procedures include:

Reviewing information obtained from external sources such as trade and

economic journals; reports by analysts, banks, or rating agencies; or regulatory

or financial publications.

Making inquiries of the entity’s external legal counsel or of valuation experts

that the entity has used.

Inquiries of Management, the Internal Audit Function and Others within the Entity (Ref: Para.

6(a))

A6. Much of the information obtained by the auditor’s inquiries is obtained from

management and those responsible for financial reporting. Information may also be

obtained by the auditor through inquiries with the internal audit function, if the entity

has such a function, and others within the entity.

3a

As explained in paragraph A2-1 of ISA (Ireland) 580, Written Representations, it is appropriate for

written representations that are critical to obtaining sufficient appropriate audit evidence to be

provided by those charged with governance, rather than other levels of the entity's management. 4 ISA (Ireland) 240, The Auditor’s Responsibilities Relating to Fraud in an Audit of Financial

Statements, paragraphs 12-24.

ISA (Ireland) 315

9

A7. The auditor may also obtain information, or a different perspective in identifying risks

of material misstatement, through inquiries of others within the entity and other

employees with different levels of authority. For example:

Inquiries directed towards those charged with governance may help the auditor

understand the environment in which the financial statements are prepared.

ISA (Ireland) 2605 identifies the importance of effective two-way communication

in assisting the auditor to obtain information from those charged with

governance in this regard.

Inquiries of employees involved in initiating, processing or recording complex or

unusual transactions may help the auditor to evaluate the appropriateness of

the selection and application of certain accounting policies.

Inquiries directed toward in-house legal counsel may provide information about

such matters as litigation, compliance with laws and regulations, knowledge of

fraud or suspected fraud affecting the entity, warranties, post-sales obligations,

arrangements (such as joint ventures) with business partners and the meaning

of contract terms.

Inquiries directed towards marketing or sales personnel may provide

information about changes in the entity’s marketing strategies, sales trends, or

contractual arrangements with its customers.

• Inquiries directed to the risk management function (or those performing such

roles) may provide information about operational and regulatory risks that may

affect financial reporting.

• Inquiries directed to information systems personnel may provide information

about system changes, system or control failures, or other information system-

related risks.

A8. As obtaining an understanding of the entity and its environment is a continual,

dynamic process, the auditor’s inquiries may occur throughout the audit engagement.

Inquiries of the Internal Audit Function

A9. If an entity has an internal audit function, inquiries of the appropriate individuals

within the function may provide information that is useful to the auditor in obtaining an

understanding of the entity and its environment, and in identifying and assessing

risks of material misstatement at the financial statement and assertion levels. In

performing its work, the internal audit function is likely to have obtained insight into

the entity’s operations and business risks, and may have findings based on its work,

such as identified control deficiencies or risks, that may provide valuable input into

the auditor’s understanding of the entity, the auditor’s risk assessments or other

aspects of the audit. The auditor’s inquiries are therefore made whether or not the

auditor expects to use the work of the internal audit function to modify the nature or

timing, or reduce the extent, of audit procedures to be performed.6 Inquiries of

particular relevance may be about matters the internal audit function has raised with

those charged with governance and the outcomes of the function’s own risk

assessment process.

5 ISA (Ireland) 260, Communication with Those Charged with Governance, paragraph 4(b).

6 The relevant requirements are contained in ISA (Ireland) 610).

ISA (Ireland) 315

10

A10. If, based on responses to the auditor’s inquiries, it appears that there are findings that

may be relevant to the entity’s financial reporting and the audit, the auditor may

consider it appropriate to read related reports of the internal audit function. Examples

of reports of the internal audit function that may be relevant include the function’s

strategy and planning documents and reports that have been prepared for

management or those charged with governance describing the findings of the internal

audit function’s examinations.

A11. In addition, in accordance with ISA (Ireland) 240,7 if the internal audit function

provides information to the auditor regarding any actual, suspected or alleged fraud,

the auditor takes this into account in the auditor’s identification of risk of material

misstatement due to fraud.

A12. Appropriate individuals within the internal audit function with whom inquiries are

made are those who, in the auditor’s judgment, have the appropriate knowledge,

experience and authority, such as the chief internal audit executive or, depending on

the circumstances, other personnel within the function. The auditor may also consider

it appropriate to have periodic meetings with these individuals.

Considerations specific to public sector entities (Ref: Para 6(a))

A13. Auditors of public sector entities often have additional responsibilities with regard to

internal control and compliance with applicable laws and regulations. Inquiries of

appropriate individuals in the internal audit function can assist the auditors in

identifying the risk of material noncompliance with applicable laws and regulations

and the risk of deficiencies in internal control over financial reporting.

Analytical Procedures (Ref: Para. 6(b))

A14. Analytical procedures performed as risk assessment procedures may identify

aspects of the entity of which the auditor was unaware and may assist in assessing

the risks of material misstatement in order to provide a basis for designing and

implementing responses to the assessed risks. Analytical procedures performed as

risk assessment procedures may include both financial and non-financial information,

for example, the relationship between sales and square footage of selling space or

volume of goods sold.

A15. Analytical procedures may help identify the existence of unusual transactions or

events, and amounts, ratios, and trends that might indicate matters that have audit

implications. Unusual or unexpected relationships that are identified may assist the

auditor in identifying risks of material misstatement, especially risks of material

misstatement due to fraud.

A16. However, when such analytical procedures use data aggregated at a high level

(which may be the situation with analytical procedures performed as risk assessment

procedures), the results of those analytical procedures only provide a broad initial

indication about whether a material misstatement may exist. Accordingly, in such

cases, consideration of other information that has been gathered when identifying the

risks of material misstatement together with the results of such analytical procedures

may assist the auditor in understanding and evaluating the results of the analytical

procedures.

7 ISA (Ireland) 240, paragraph 19.

ISA (Ireland) 315

11

Considerations Specific to Smaller Entities

A17. Some smaller entities may not have interim or monthly financial information that can

be used for purposes of analytical procedures. In these circumstances, although the

auditor may be able to perform limited analytical procedures for purposes of planning

the audit or obtain some information through inquiry, the auditor may need to plan to

perform analytical procedures to identify and assess the risks of material

misstatement when an early draft of the entity’s financial statements is available.

Observation and Inspection (Ref: Para. 6(c))

A18. Observation and inspection may support inquiries of management and others, and

may also provide information about the entity and its environment. Examples of such

audit procedures include observation or inspection of the following:

The entity’s operations.

Documents (such as business plans and strategies), records, and internal

control manuals.

Reports prepared by management (such as quarterly management reports and

interim financial statements) and those charged with governance (such as

minutes of board of directors’ meetings).

The entity’s premises and plant facilities.

Information Obtained in Prior Periods (Ref: Para. 9)

A19. The auditor’s previous experience with the entity and audit procedures performed in

previous audits may provide the auditor with information about such matters as:

Past misstatements and whether they were corrected on a timely basis.

The nature of the entity and its environment, and the entity’s internal control

(including deficiencies in internal control).

Significant changes that the entity or its operations may have undergone since

the prior financial period, which may assist the auditor in gaining a sufficient

understanding of the entity to identify and assess risks of material

misstatement.

Those particular types of transactions and other events or account balances

(and related disclosures) where the auditor experienced difficulty in performing

the necessary audit procedures, for example due to their complexity.

A20. The auditor is required to determine whether information obtained in prior periods

remains relevant, if the auditor intends to use that information for the purposes of the

current audit. This is because changes in the control environment, for example, may

affect the relevance of information obtained in the prior year. To determine whether

changes have occurred that may affect the relevance of such information, the auditor

may make inquiries and perform other appropriate audit procedures, such as walk-

throughs of relevant systems.

ISA (Ireland) 315

12

Discussion among the Engagement Team (Ref: Para. 10)

A21. The discussion among the engagement team about the susceptibility of the entity’s

financial statements to material misstatement:

Provides an opportunity for more experienced engagement team members,

including the engagement partner, to share their insights based on their

knowledge of the entity.

Allows the engagement team members to exchange information about the

business risks to which the entity is subject and about how and where the

financial statements might be susceptible to material misstatement due to fraud

or error.

Assists the engagement team members to gain a better understanding of the

potential for material misstatement of the financial statements in the specific

areas assigned to them, and to understand how the results of the audit

procedures that they perform may affect other aspects of the audit including the

decisions about the nature, timing, and extent of further audit procedures.

Provides a basis upon which engagement team members communicate and

share new information obtained throughout the audit that may affect the

assessment of risks of material misstatement or the audit procedures

performed to address these risks.

ISA (Ireland) 240 provides further requirements and guidance in relation to the

discussion among the engagement team about the risks of fraud.8

A21a. As part of the discussion among the engagement team required by paragraph 10,

consideration of the disclosure requirements of the applicable financial reporting

framework assists in identifying early in the audit where there may be risks of

material misstatement in relation to disclosures. Examples of matters the

engagement team may discuss include:

Changes in financial reporting requirements that may result in significant new or

revised disclosures;

Changes in the entity’s environment, financial condition or activities that may

result in significant new or revised disclosures, for example, a significant

business combination in the period under audit;

Disclosures for which obtaining sufficient appropriate audit evidence may have

been difficult in the past; and

Disclosures about complex matters, including those involving significant

management judgment as to what information to disclose.

A22. It is not always necessary or practical for the discussion to include all members in a

single discussion (as, for example, in a multi-location audit), nor is it necessary for all

of the members of the engagement team to be informed of all of the decisions

reached in the discussion. The engagement partner may discuss matters with key

members of the engagement team including, if considered appropriate, those with

specific skills or knowledge, and those responsible for the audits of components,

while delegating discussion with others, taking account of the extent of

8 ISA (Ireland) 240, paragraph 15.

ISA (Ireland) 315

13

communication considered necessary throughout the engagement team. A

communications plan, agreed by the engagement partner, may be useful.

Considerations Specific to Smaller Entities

A23. Many small audits are carried out entirely by the engagement partner (who may be a

sole practitioner). In such situations, it is the engagement partner who, having

personally conducted the planning of the audit, would be responsible for considering

the susceptibility of the entity’s financial statements to material misstatement due to

fraud or error.

The Required Understanding of the Entity and Its Environment, Including the Entity’s

Internal Control

The Entity and Its Environment

Industry, Regulatory and Other External Factors (Ref: Para. 11(a))

Industry Factors

A24. Relevant industry factors include industry conditions such as the competitive

environment, supplier and customer relationships, and technological developments.

Examples of matters the auditor may consider include:

The market and competition, including demand, capacity, and price

competition.

Cyclical or seasonal activity.

Product technology relating to the entity’s products.

Energy supply and cost.

A25. The industry in which the entity operates may give rise to specific risks of material

misstatement arising from the nature of the business or the degree of regulation. For

example, long-term contracts may involve significant estimates of revenues and

expenses that give rise to risks of material misstatement. In such cases, it is

important that the engagement team include members with sufficient relevant

knowledge and experience.9

Regulatory Factors

A26. Relevant regulatory factors include the regulatory environment. The regulatory

environment encompasses, among other matters, the applicable financial reporting

framework and the legal and political environment. Examples of matters the auditor

may consider include:

Accounting principles and industry specific practices.

Regulatory framework for a regulated industry, including requirements for

disclosures.

Legislation and regulation that significantly affect the entity’s operations,

including direct supervisory activities.

Taxation (corporate and other).

9 ISA (Ireland) 220, Quality Control for an Audit of Financial Statements, paragraph 14.

ISA (Ireland) 315

14

Government policies currently affecting the conduct of the entity’s business,

such as monetary, including foreign exchange controls, fiscal, financial

incentives (for example, government aid programs), and tariffs or trade

restrictions policies.

Environmental requirements affecting the industry and the entity’s business.

A27. ISA (Ireland) 250 includes some specific requirements related to the legal and

regulatory framework applicable to the entity and the industry or sector in which the

entity operates.10

Considerations specific to public sector entities

A28. For the audits of public sector entities, law, regulation or other authority may affect

the entity’s operations. Such elements are essential to consider when obtaining an

understanding of the entity and its environment.

Other External Factors

A29. Examples of other external factors affecting the entity that the auditor may consider

include the general economic conditions, interest rates and availability of financing,

and inflation or currency revaluation.

Nature of the Entity (Ref: Para. 11(b))

A30. An understanding of the nature of an entity enables the auditor to understand such

matters as:

Whether the entity has a complex structure, for example with subsidiaries or

other components in multiple locations. Complex structures often introduce

issues that may give rise to risks of material misstatement. Such issues may

include whether goodwill, joint ventures, investments, or special-purpose

entities are accounted for appropriately and whether adequate disclosure of

such issues in the financial statements has been made.

The ownership, and relationships between owners and other people or entities.

This understanding assists in determining whether related party transactions

have been appropriately identified, accounted for, and adequately disclosed in

the financial statements. ISA (Ireland) 55011 establishes requirements and

provides guidance on the auditor’s considerations relevant to related parties.

A31. Examples of matters that the auditor may consider when obtaining an understanding

of the nature of the entity include:

Business operations such as:

○ Nature of revenue sources, products or services, and markets, including

involvement in electronic commerce such as Internet sales and marketing

activities.

○ Conduct of operations (for example, stages and methods of production,

or activities exposed to environmental risks).

○ Alliances, joint ventures, and outsourcing activities.

10

ISA (Ireland) 250, Consideration of Laws and Regulations in an Audit of Financial Statements,

paragraph 12. 11

ISA (Ireland) 550, Related Parties.

ISA (Ireland) 315

15

○ Geographic dispersion and industry segmentation.

○ Location of production facilities, warehouses, and offices, and location

and quantities of inventories.

○ Key customers and important suppliers of goods and services,

employment arrangements (including the existence of union contracts,

pension and other post employment benefits, stock option or incentive

bonus arrangements, and government regulation related to employment

matters).

○ Research and development activities and expenditures.

○ Transactions with related parties.

Investments and investment activities such as:

○ Planned or recently executed acquisitions or divestitures.

○ Investments and dispositions of securities and loans.

○ Capital investment activities.

○ Investments in non-consolidated entities, including partnerships, joint

ventures and special-purpose entities.

Financing and financing activities such as:

○ Major subsidiaries and associated entities, including consolidated and

non-consolidated structures.

○ Debt structure and related terms, including off-balance-sheet financing

arrangements and leasing arrangements.

○ Beneficial owners (local, foreign, business reputation and experience)

and related parties.

○ Use of derivative financial instruments.

Financial reporting practices such as:

○ Accounting principles and industry specific practices, including for

industry-specific significant classes of transactions, account balances and

related disclosures in the financial statements (for example, loans and

investments for banks, or research and development for

pharmaceuticals).

○ Revenue recognition.

○ Accounting for fair values.

○ Foreign currency assets, liabilities and transactions.

○ Accounting for unusual or complex transactions including those in

controversial or emerging areas (for example, accounting for stock-based

compensation).

A32. Significant changes in the entity from prior periods may give rise to, or change, risks

of material misstatement.

ISA (Ireland) 315

16

Nature of Special-Purpose Entities

A33. A special-purpose entity (sometimes referred to as a special-purpose vehicle) is an

entity that is generally established for a narrow and well-defined purpose, such as to

effect a lease or a securitization of financial assets, or to carry out research and

development activities. It may take the form of a corporation, trust, partnership or

unincorporated entity. The entity on behalf of which the special-purpose entity has

been created may often transfer assets to the latter (for example, as part of a

derecognition transaction involving financial assets), obtain the right to use the

latter’s assets, or perform services for the latter, while other parties may provide the

funding to the latter. As ISA (Ireland) 550 indicates, in some circumstances, a special-

purpose entity may be a related party of the entity.12

A34. Financial reporting frameworks often specify detailed conditions that are deemed to

amount to control, or circumstances under which the special-purpose entity should

be considered for consolidation. The interpretation of the requirements of such

frameworks often demands a detailed knowledge of the relevant agreements

involving the special-purpose entity.

The Entity’s Selection and Application of Accounting Policies (Ref: Para. 11(c))

A35. An understanding of the entity’s selection and application of accounting policies may

encompass such matters as:

The methods the entity uses to account for significant and unusual transactions.

The effect of significant accounting policies in controversial or emerging areas

for which there is a lack of authoritative guidance or consensus.

Changes in the entity’s accounting policies.

Financial reporting standards and laws and regulations that are new to the

entity and when and how the entity will adopt such requirements.

Objectives and Strategies and Related Business Risks (Ref: Para. 11(d))

A36. The entity conducts its business in the context of industry, regulatory and other

internal and external factors. To respond to these factors, the entity’s management or

those charged with governance define objectives, which are the overall plans for the

entity. Strategies are the approaches by which management intends to achieve its

objectives. The entity’s objectives and strategies may change over time.

A37. Business risk is broader than the risk of material misstatement of the financial

statements, though it includes the latter. Business risk may arise from change or

complexity. A failure to recognize the need for change may also give rise to business

risk. Business risk may arise, for example, from:

The development of new products or services that may fail;

A market which, even if successfully developed, is inadequate to support a

product or service; or

Flaws in a product or service that may result in liabilities and reputational risk.

A38. An understanding of the business risks facing the entity increases the likelihood of

identifying risks of material misstatement, since most business risks will eventually

12

ISA (Ireland) 550, paragraph A7.

ISA (Ireland) 315

17

have financial consequences and, therefore, an effect on the financial statements.

However, the auditor does not have a responsibility to identify or assess all business

risks because not all business risks give rise to risks of material misstatement.

A39. Examples of matters that the auditor may consider when obtaining an understanding

of the entity’s objectives, strategies and related business risks that may result in a

risk of material misstatement of the financial statements include:

Industry developments (a potential related business risk might be, for example,

that the entity does not have the personnel or expertise to deal with the

changes in the industry).

New products and services (a potential related business risk might be, for

example, that there is increased product liability).

Expansion of the business (a potential related business risk might be, for

example, that the demand has not been accurately estimated).

New accounting requirements (a potential related business risk might be, for

example, incomplete or improper implementation, or increased costs).

Regulatory requirements (a potential related business risk might be, for

example, that there is increased legal exposure).

Current and prospective financing requirements (a potential related business

risk might be, for example, the loss of financing due to the entity’s inability to

meet requirements).

Use of IT (a potential related business risk might be, for example, that systems

and processes are incompatible).

The effects of implementing a strategy, particularly any effects that will lead to

new accounting requirements (a potential related business risk might be, for

example, incomplete or improper implementation).

A40. A business risk may have an immediate consequence for the risk of material

misstatement for classes of transactions, account balances, and disclosures at the

assertion level or the financial statement level. For example, the business risk arising

from a contracting customer base may increase the risk of material misstatement

associated with the valuation of receivables. However, the same risk, particularly in

combination with a contracting economy, may also have a longer-term consequence,

which the auditor considers when assessing the appropriateness of the going

concern assumption. Whether a business risk may result in a risk of material

misstatement is, therefore, considered in light of the entity’s circumstances.

Examples of conditions and events that may indicate risks of material misstatement

are indicated in Appendix 2.

A41. Usually, management identifies business risks and develops approaches to address

them. Such a risk assessment process is part of internal control and is discussed in

paragraph 15 and paragraphs A87-A88.

Considerations Specific to Public Sector Entities

A42. For the audits of public sector entities, “management objectives” may be influenced

by concerns regarding public accountability and may include objectives which have

their source in law, regulation or other authority.

ISA (Ireland) 315

18

Measurement and Review of the Entity’s Financial Performance (Ref: Para.11(e))

A43. Management and others will measure and review those things they regard as

important. Performance measures, whether external or internal, create pressures on

the entity. These pressures, in turn, may motivate management to take action to

improve the business performance or to misstate the financial statements.

Accordingly, an understanding of the entity’s performance measures assists the

auditor in considering whether pressures to achieve performance targets may result

in management actions that increase the risks of material misstatement, including

those due to fraud. See ISA (Ireland) 240 for requirements and guidance in relation to

the risks of fraud.

A44. The measurement and review of financial performance is not the same as the

monitoring of controls (discussed as a component of internal control in paragraphs

A106-A117), though their purposes may overlap:

The measurement and review of performance is directed at whether business

performance is meeting the objectives set by management (or third parties).

Monitoring of controls is specifically concerned with the effective operation of

internal control.

In some cases, however, performance indicators also provide information that

enables management to identify deficiencies in internal control.

A45. Examples of internally-generated information used by management for measuring

and reviewing financial performance, and which the auditor may consider, include:

Key performance indicators (financial and non-financial) and key ratios, trends

and operating statistics.

Period-on-period financial performance analyses.

Budgets, forecasts, variance analyses, segment information and divisional,

departmental or other level performance reports.

Employee performance measures and incentive compensation policies.

Comparisons of an entity’s performance with that of competitors.

A46. External parties may also measure and review the entity’s financial performance. For

example, external information such as analysts’ reports and credit rating agency

reports may represent useful information for the auditor. Such reports can often be

obtained from the entity being audited.

A47. Internal measures may highlight unexpected results or trends requiring management

to determine their cause and take corrective action (including, in some cases, the

detection and correction of misstatements on a timely basis). Performance measures

may also indicate to the auditor that risks of misstatement of related financial

statement information do exist. For example, performance measures may indicate

that the entity has unusually rapid growth or profitability when compared to that of

other entities in the same industry. Such information, particularly if combined with

other factors such as performance-based bonus or incentive remuneration, may

indicate the potential risk of management bias in the preparation of the financial

statements.

ISA (Ireland) 315

19

Considerations Specific to Smaller Entities

A48. Smaller entities often do not have processes to measure and review financial

performance. Inquiry of management may reveal that it relies on certain key

indicators for evaluating financial performance and taking appropriate action. If such

inquiry indicates an absence of performance measurement or review, there may be

an increased risk of misstatements not being detected and corrected.

The Entity’s Internal Control (Ref: Para. 12)

A49. An understanding of internal control assists the auditor in identifying types of

potential misstatements and factors that affect the risks of material misstatement,

and in designing the nature, timing, and extent of further audit procedures.

A50. The following application material on internal control is presented in four sections, as

follows:

General Nature and Characteristics of Internal Control.

Controls Relevant to the Audit.

Nature and Extent of the Understanding of Relevant Controls.

Components of Internal Control.

General Nature and Characteristics of Internal Control

Purpose of Internal Control

A51. Internal control is designed, implemented and maintained to address identified

business risks that threaten the achievement of any of the entity’s objectives that

concern:

The reliability of the entity’s financial reporting;

The effectiveness and efficiency of its operations; and

Its compliance with applicable laws and regulations.

The way in which internal control is designed, implemented and maintained varies

with an entity’s size and complexity.

Considerations specific to smaller entities

A52. Smaller entities may use less structured means and simpler processes and

procedures to achieve their objectives.

Limitations of Internal Control

A53. Internal control, no matter how effective, can provide an entity with only reasonable

assurance about achieving the entity’s financial reporting objectives. The likelihood of

their achievement is affected by the inherent limitations of internal control. These

include the realities that human judgment in decision-making can be faulty and that

breakdowns in internal control can occur because of human error. For example, there

may be an error in the design of, or in the change to, a control. Equally, the operation

of a control may not be effective, such as where information produced for the

purposes of internal control (for example, an exception report) is not effectively used

because the individual responsible for reviewing the information does not understand

its purpose or fails to take appropriate action.

ISA (Ireland) 315

20

A54. Additionally, controls can be circumvented by the collusion of two or more people or

inappropriate management override of internal control. For example, management

may enter into side agreements with customers that alter the terms and conditions of

the entity’s standard sales contracts, which may result in improper revenue

recognition. Also, edit checks in a software program that are designed to identify and

report transactions that exceed specified credit limits may be overridden or disabled.

A55. Further, in designing and implementing controls, management may make judgments

on the nature and extent of the controls it chooses to implement, and the nature and

extent of the risks it chooses to assume.

Considerations specific to smaller entities

A56. Smaller entities often have fewer employees which may limit the extent to which

segregation of duties is practicable. However, in a small owner-managed entity, the

owner-manager may be able to exercise more effective oversight than in a larger

entity. This oversight may compensate for the generally more limited opportunities for

segregation of duties.

A57. On the other hand, the owner-manager may be more able to override controls

because the system of internal control is less structured. This is taken into account

by the auditor when identifying the risks of material misstatement due to fraud.

Division of Internal Control into Components

A58. The division of internal control into the following five components, for purposes of the

ISAs (Ireland), provides a useful framework for auditors to consider how different

aspects of an entity’s internal control may affect the audit:

(a) The control environment;

(b) The entity’s risk assessment process;

(c) The information system, including the related business processes, relevant to

financial reporting, and communication;

(d) Control activities; and

(e) Monitoring of controls.

The division does not necessarily reflect how an entity designs, implements and

maintains internal control, or how it may classify any particular component. Auditors

may use different terminology or frameworks to describe the various aspects of

internal control, and their effect on the audit than those used in this ISA (Ireland),

provided all the components described in this ISA (Ireland) are addressed.

A59. Application material relating to the five components of internal control as they relate

to a financial statement audit is set out in paragraphs A76-A117 below. Appendix 1

provides further explanation of these components of internal control.

Characteristics of Manual and Automated Elements of Internal Control Relevant to the

Auditor’s Risk Assessment

A60. An entity’s system of internal control contains manual elements and often contains

automated elements. The characteristics of manual or automated elements are

relevant to the auditor’s risk assessment and further audit procedures based thereon.

A61. The use of manual or automated elements in internal control also affects the manner

in which transactions are initiated, recorded, processed, and reported:

ISA (Ireland) 315

21

Controls in a manual system may include such procedures as approvals and

reviews of transactions, and reconciliations and follow-up of reconciling items.

Alternatively, an entity may use automated procedures to initiate, record,

process, and report transactions, in which case records in electronic format

replace paper documents.

Controls in IT systems consist of a combination of automated controls (for

example, controls embedded in computer programs) and manual controls.

Further, manual controls may be independent of IT, may use information

produced by IT, or may be limited to monitoring the effective functioning of IT

and of automated controls, and to handling exceptions. When IT is used to

initiate, record, process or report transactions, or other financial data for

inclusion in financial statements, the systems and programs may include

controls related to the corresponding assertions for material accounts or may

be critical to the effective functioning of manual controls that depend on IT.

An entity’s mix of manual and automated elements in internal control varies with the

nature and complexity of the entity’s use of IT.

A62. Generally, IT benefits an entity’s internal control by enabling an entity to:

Consistently apply predefined business rules and perform complex calculations

in processing large volumes of transactions or data;

Enhance the timeliness, availability, and accuracy of information;

Facilitate the additional analysis of information;

Enhance the ability to monitor the performance of the entity’s activities and its

policies and procedures;

Reduce the risk that controls will be circumvented; and

Enhance the ability to achieve effective segregation of duties by implementing

security controls in applications, databases, and operating systems.

A63. IT also poses specific risks to an entity’s internal control, including, for example:

Reliance on systems or programs that are inaccurately processing data,

processing inaccurate data, or both.

Unauthorized access to data that may result in destruction of data or improper

changes to data, including the recording of unauthorized or non-existent

transactions, or inaccurate recording of transactions. Particular risks may arise

where multiple users access a common database.

The possibility of IT personnel gaining access privileges beyond those

necessary to perform their assigned duties thereby breaking down segregation

of duties.

Unauthorized changes to data in master files.

Unauthorized changes to systems or programs.

Failure to make necessary changes to systems or programs.

Inappropriate manual intervention.

Potential loss of data or inability to access data as required.

ISA (Ireland) 315

22

A64. Manual elements in internal control may be more suitable where judgment and

discretion are required such as for the following circumstances:

Large, unusual or non-recurring transactions.

Circumstances where errors are difficult to define, anticipate or predict.

In changing circumstances that require a control response outside the scope of

an existing automated control.

In monitoring the effectiveness of automated controls.

A65. Manual elements in internal control may be less reliable than automated elements

because they can be more easily bypassed, ignored, or overridden and they are also

more prone to simple errors and mistakes. Consistency of application of a manual

control element cannot therefore be assumed. Manual control elements may be less

suitable for the following circumstances:

High volume or recurring transactions, or in situations where errors that can be

anticipated or predicted can be prevented, or detected and corrected, by control

parameters that are automated.

Control activities where the specific ways to perform the control can be

adequately designed and automated.

A66. The extent and nature of the risks to internal control vary depending on the nature

and characteristics of the entity’s information system. The entity responds to the risks

arising from the use of IT or from use of manual elements in internal control by

establishing effective controls in light of the characteristics of the entity’s information

system.

Controls Relevant to the Audit

A67. There is a direct relationship between an entity’s objectives and the controls it

implements to provide reasonable assurance about their achievement. The entity’s

objectives, and therefore controls, relate to financial reporting, operations and

compliance; however, not all of these objectives and controls are relevant to the

auditor’s risk assessment.

A68. Factors relevant to the auditor’s judgment about whether a control, individually or in

combination with others, is relevant to the audit may include such matters as the

following:

Materiality.

The significance of the related risk.

The size of the entity.

The nature of the entity’s business, including its organization and ownership

characteristics.

The diversity and complexity of the entity’s operations.

Applicable legal and regulatory requirements.

The circumstances and the applicable component of internal control.

The nature and complexity of the systems that are part of the entity’s internal

control, including the use of service organizations.

ISA (Ireland) 315

23

Whether, and how, a specific control, individually or in combination with others,

prevents, or detects and corrects, material misstatement.

A69. Controls over the completeness and accuracy of information produced by the entity

may be relevant to the audit if the auditor intends to make use of the information in

designing and performing further procedures. Controls relating to operations and

compliance objectives may also be relevant to an audit if they relate to data the

auditor evaluates or uses in applying audit procedures.

A70. Internal control over safeguarding of assets against unauthorized acquisition, use, or

disposition may include controls relating to both financial reporting and operations

objectives. The auditor’s consideration of such controls is generally limited to those

relevant to the reliability of financial reporting.

A71. An entity generally has controls relating to objectives that are not relevant to an audit

and therefore need not be considered. For example, an entity may rely on a

sophisticated system of automated controls to provide efficient and effective

operations (such as an airline’s system of automated controls to maintain flight

schedules), but these controls ordinarily would not be relevant to the audit. Further,

although internal control applies to the entire entity or to any of its operating units or

business processes, an understanding of internal control relating to each of the

entity’s operating units and business processes may not be relevant to the audit.

Considerations Specific to Public Sector Entities

A72. Public sector auditors often have additional responsibilities with respect to internal

control, for example to report on compliance with an established code of practice.

Public sector auditors can also have responsibilities to report on compliance with law,

regulation or other authority. As a result, their review of internal control may be

broader and more detailed.

Nature and Extent of the Understanding of Relevant Controls (Ref: Para. 13)

A73. Evaluating the design of a control involves considering whether the control,

individually or in combination with other controls, is capable of effectively preventing,

or detecting and correcting, material misstatements. Implementation of a control

means that the control exists and that the entity is using it. There is little point in

assessing the implementation of a control that is not effective, and so the design of a

control is considered first. An improperly designed control may represent a significant

deficiency in internal control.

A74. Risk assessment procedures to obtain audit evidence about the design and

implementation of relevant controls may include:

Inquiring of entity personnel.

Observing the application of specific controls.

Inspecting documents and reports.

Tracing transactions through the information system relevant to financial

reporting.

Inquiry alone, however, is not sufficient for such purposes.

A75. Obtaining an understanding of an entity’s controls is not sufficient to test their

operating effectiveness, unless there is some automation that provides for the

ISA (Ireland) 315

24

consistent operation of the controls. For example, obtaining audit evidence about the

implementation of a manual control at a point in time does not provide audit evidence

about the operating effectiveness of the control at other times during the period under

audit. However, because of the inherent consistency of IT processing (see paragraph

A62), performing audit procedures to determine whether an automated control has

been implemented may serve as a test of that control’s operating effectiveness,

depending on the auditor’s assessment and testing of controls such as those over

program changes. Tests of the operating effectiveness of controls are further

described in ISA (Ireland) 330.13

Components of Internal Control—Control Environment (Ref: Para. 14)

A76. The control environment includes the governance and management functions and

the attitudes, awareness, and actions of those charged with governance and

management concerning the entity’s internal control and its importance in the entity.

The control environment sets the tone of an organization, influencing the control

consciousness of its people.

A77. Elements of the control environment that may be relevant when obtaining an

understanding of the control environment include the following:

(a) Communication and enforcement of integrity and ethical values – These are

essential elements that influence the effectiveness of the design, administration

and monitoring of controls.

(b) Commitment to competence – Matters such as management’s consideration of

the competence levels for particular jobs and how those levels translate into

requisite skills and knowledge.

(c) Participation by those charged with governance – Attributes of those charged

with governance such as:

Their independence from management.

Their experience and stature.

The extent of their involvement and the information they receive, and the

scrutiny of activities.

The appropriateness of their actions, including the degree to which

difficult questions are raised and pursued with management, and their

interaction with internal and external auditors.

(d) Management’s philosophy and operating style – Characteristics such as

management’s:

Approach to taking and managing business risks.

Attitudes and actions toward financial reporting.

Attitudes toward information processing and accounting functions and

personnel.

(e) Organizational structure – The framework within which an entity’s activities for

achieving its objectives are planned, executed, controlled, and reviewed.

13

ISA (Ireland) 330, The Auditor’s Responses to Assessed Risks.

ISA (Ireland) 315

25

(f) Assignment of authority and responsibility – Matters such as how authority and

responsibility for operating activities are assigned and how reporting

relationships and authorization hierarchies are established.

(g) Human resource policies and practices – Policies and practices that relate to,

for example, recruitment, orientation, training, evaluation, counselling,

promotion, compensation, and remedial actions.

Audit Evidence for Elements of the Control Environment

A78. Relevant audit evidence may be obtained through a combination of inquiries and

other risk assessment procedures such as corroborating inquiries through

observation or inspection of documents. For example, through inquiries of

management and employees, the auditor may obtain an understanding of how

management communicates to employees its views on business practices and

ethical behavior. The auditor may then determine whether relevant controls have

been implemented by considering, for example, whether management has a written

code of conduct and whether it acts in a manner that supports the code.

A79. The auditor may also consider how management has responded to the findings and

recommendations of the internal audit function regarding identified deficiencies in

internal control relevant to the audit, including whether and how such responses have

been implemented, and whether they have been subsequently evaluated by the

internal audit function.

Effect of the Control Environment on the Assessment of the Risks of Material Misstatement

A80. Some elements of an entity’s control environment have a pervasive effect on

assessing the risks of material misstatement. For example, an entity’s control

consciousness is influenced significantly by those charged with governance, because

one of their roles is to counterbalance pressures on management in relation to

financial reporting that may arise from market demands or remuneration schemes.

The effectiveness of the design of the control environment in relation to participation

by those charged with governance is therefore influenced by such matters as:

Their independence from management and their ability to evaluate the actions

of management.

Whether they understand the entity’s business transactions.

The extent to which they evaluate whether the financial statements are

prepared in accordance with the applicable financial reporting framework,

including whether the financial statements include adequate disclosures.

A81. An active and independent board of directors may influence the philosophy and

operating style of senior management. However, other elements may be more limited

in their effect. For example, although human resource policies and practices directed

toward hiring competent financial, accounting, and IT personnel may reduce the risk

of errors in processing financial information, they may not mitigate a strong bias by

top management to overstate earnings.

A82. The existence of a satisfactory control environment can be a positive factor when the

auditor assesses the risks of material misstatement. However, although it may help

reduce the risk of fraud, a satisfactory control environment is not an absolute

deterrent to fraud. Conversely, deficiencies in the control environment may

undermine the effectiveness of controls, in particular in relation to fraud. For

ISA (Ireland) 315

26

example, management’s failure to commit sufficient resources to address IT security

risks may adversely affect internal control by allowing improper changes to be made

to computer programs or to data, or unauthorized transactions to be processed. As

explained in ISA (Ireland) 330, the control environment also influences the nature,

timing, and extent of the auditor’s further procedures.14

A83. The control environment in itself does not prevent, or detect and correct, a material

misstatement. It may, however, influence the auditor’s evaluation of the effectiveness

of other controls (for example, the monitoring of controls and the operation of specific

control activities) and thereby, the auditor’s assessment of the risks of material

misstatement.

Considerations Specific to Smaller Entities

A84. The control environment within small entities is likely to differ from larger entities. For

example, those charged with governance in small entities may not include an

independent or outside member, and the role of governance may be undertaken

directly by the owner-manager where there are no other owners. The nature of the

control environment may also influence the significance of other controls, or their

absence. For example, the active involvement of an owner-manager may mitigate

certain of the risks arising from a lack of segregation of duties in a small entity; it

may, however, increase other risks, for example, the risk of override of controls.

A85. In addition, audit evidence for elements of the control environment in smaller entities

may not be available in documentary form, in particular where communication between

management and other personnel may be informal, yet effective. For example, small

entities might not have a written code of conduct but, instead, develop a culture that

emphasizes the importance of integrity and ethical behavior through oral

communication and by management example.

A86. Consequently, the attitudes, awareness and actions of management or the owner-

manager are of particular importance to the auditor’s understanding of a smaller

entity’s control environment.

Components of Internal Control—The Entity’s Risk Assessment Process (Ref: Para. 15)

A87. The entity’s risk assessment process forms the basis for how management determines

the risks to be managed. If that process is appropriate to the circumstances, including

the nature, size and complexity of the entity, it assists the auditor in identifying risks of

material misstatement. Whether the entity’s risk assessment process is appropriate to

the circumstances is a matter of judgment.

Considerations Specific to Smaller Entities (Ref: Para. 17)

A88. There is unlikely to be an established risk assessment process in a small entity. In

such cases, it is likely that management will identify risks through direct personal

involvement in the business. Irrespective of the circumstances, however, inquiry

about identified risks and how they are addressed by management is still necessary.

14

ISA (Ireland) 330, paragraphs A2-A3.

ISA (Ireland) 315

27

Components of Internal Control—The Information System, Including Related Business

Processes, Relevant to Financial Reporting, and Communication

The Information System, Including Related Business Processes, Relevant to Financial

Reporting (Ref: Para. 18)

A89. The information system relevant to financial reporting objectives, which includes the

accounting system, consists of the procedures and records designed and established

to:

Initiate, record, process, and report entity transactions (as well as events and

conditions) and to maintain accountability for the related assets, liabilities, and

equity;

Resolve incorrect processing of transactions, for example, automated suspense

files and procedures followed to clear suspense items out on a timely basis;

Process and account for system overrides or bypasses to controls;

Transfer information from transaction processing systems to the general ledger;

Capture information relevant to financial reporting for events and conditions

other than transactions, such as the depreciation and amortization of assets

and changes in the recoverability of accounts receivables; and

Ensure information required to be disclosed by the applicable financial reporting

framework is accumulated, recorded, processed, summarized and appropriately

reported in the financial statements.

A89a. Financial statements may contain information that is obtained from outside of the

general and subsidiary ledgers. Examples of such information may include:

Information obtained from lease agreements disclosed in the financial

statements, such as renewal options or future lease payments.

Information disclosed in the financial statements that is produced by an entity’s

risk management system.

Fair value information produced by management’s experts and disclosed in the

financial statements.

Information disclosed in the financial statements that has been obtained from

models, or from other calculations used to develop estimates recognized or

disclosed in the financial statements, including information relating to the

underlying data and assumptions used in those models, such as:

o Assumptions developed internally that may affect an asset’s useful life; or

o Data such as interest rates that are affected by factors outside the control

of the entity.

Information disclosed in the financial statements about sensitivity analyses

derived from financial models that demonstrates that management has

considered alternative assumptions.

Information recognized or disclosed in the financial statements that has been

obtained from an entity’s tax returns and records.

Information disclosed in the financial statements that has been obtained from

analyses prepared to support management’s assessment of the entity’s ability

ISA (Ireland) 315

28

to continue as a going concern, such as disclosures, if any, related to events or

conditions that have been identified that may cast significant doubt on the

entity’s ability to continue as a going concern.15

A89b. The understanding of the information system relevant to financial reporting required

by paragraph 18 of this ISA (Ireland) (including the understanding of relevant aspects

of that system relating to information disclosed in the financial statements that is

obtained from within or outside of the general and subsidiary ledgers) is a matter of

the auditor’s professional judgment. For example, certain amounts or disclosures in

the entity’s financial statements (such as disclosures about credit risk, liquidity risk,

and market risk) may be based on information obtained from the entity’s risk

management system. However, the auditor is not required to understand all aspects

of the risk management system, and uses professional judgment in determining the

necessary understanding.

Journal entries

A90. An entity’s information system typically includes the use of standard journal entries

that are required on a recurring basis to record transactions. Examples might be

journal entries to record sales, purchases, and cash disbursements in the general

ledger, or to record accounting estimates that are periodically made by management,

such as changes in the estimate of uncollectible accounts receivable.

A91. An entity’s financial reporting process also includes the use of non-standard journal

entries to record non-recurring, unusual transactions or adjustments. Examples of

such entries include consolidating adjustments and entries for a business

combination or disposal or non-recurring estimates such as the impairment of an

asset. In manual general ledger systems, non-standard journal entries may be

identified through inspection of ledgers, journals, and supporting documentation.

When automated procedures are used to maintain the general ledger and prepare

financial statements, such entries may exist only in electronic form and may therefore

be more easily identified through the use of computer-assisted audit techniques.

Related business processes

A92. An entity’s business processes are the activities designed to:

Develop, purchase, produce, sell and distribute an entity’s products and

services;

Ensure compliance with laws and regulations; and

Record information, including accounting and financial reporting information.

Business processes result in the transactions that are recorded, processed and

reported by the information system. Obtaining an understanding of the entity’s

business processes, which include how transactions are originated, assists the

auditor obtain an understanding of the entity’s information system relevant to

financial reporting in a manner that is appropriate to the entity’s circumstances.

Considerations specific to smaller entities

A93. The information system, and related business processes, relevant to financial reporting

in small entities, including relevant aspects of that system relating to information

15

See paragraphs 19‒20 of ISA (Ireland) 570, Going Concern.

ISA (Ireland) 315

29

disclosed in the financial statements that is obtained from within or outside of the

general and subsidiary ledgers, is likely to be less sophisticated than in larger entities,

but its role is just as significant. Small entities with active management involvement

may not need extensive descriptions of accounting procedures, sophisticated

accounting records, or written policies. Understanding the entity’s information system

relevant to financial reporting may therefore be easier in an audit of smaller entities,

and may be more dependent on inquiry than on review of documentation. The need to

obtain an understanding, however, remains important.

Communication (Ref: Para. 19)

A94. Communication by the entity of the financial reporting roles and responsibilities and

of significant matters relating to financial reporting involves providing an

understanding of individual roles and responsibilities pertaining to internal control

over financial reporting. It includes such matters as the extent to which personnel

understand how their activities in the financial reporting information system relate to

the work of others and the means of reporting exceptions to an appropriate higher

level within the entity. Communication may take such forms as policy manuals and

financial reporting manuals. Open communication channels help ensure that

exceptions are reported and acted on.

Considerations specific to smaller entities

A95. Communication may be less structured and easier to achieve in a small entity than in

a larger entity due to fewer levels of responsibility and management’s greater

visibility and availability.

Components of Internal Control—Control Activities Relevant to the Audit (Ref: Para. 20)

A96. Control activities are the policies and procedures that help ensure that management

directives are carried out. Control activities, whether within IT or manual systems,

have various objectives and are applied at various organizational and functional

levels. Examples of specific control activities include those relating to the following:

Authorization.

Performance reviews.

Information processing.

Physical controls.

Segregation of duties.

A97. Control activities that are relevant to the audit are:

Those that are required to be treated as such, being control activities that relate

to significant risks and those that relate to risks for which substantive

procedures alone do not provide sufficient appropriate audit evidence, as

required by paragraphs 29 and 30, respectively; or

Those that are considered to be relevant in the judgment of the auditor.

A98. The auditor’s judgment about whether a control activity is relevant to the audit is

influenced by the risk that the auditor has identified that may give rise to a material

misstatement and whether the auditor thinks it is likely to be appropriate to test the

operating effectiveness of the control in determining the extent of substantive testing.

ISA (Ireland) 315

30

A99. The auditor’s emphasis may be on identifying and obtaining an understanding of

control activities that address the areas where the auditor considers that risks of

material misstatement are likely to be higher. When multiple control activities each

achieve the same objective, it is unnecessary to obtain an understanding of each of

the control activities related to such objective.

A99a. Control activities relevant to the audit may include controls established by

management that address risks of material misstatement related to disclosures not

being prepared in accordance with the applicable financial reporting framework, in

addition to controls that address risks related to account balances and transactions.

Such control activities may relate to information included in the financial statements

that is obtained from outside of the general and subsidiary ledgers.

A100. The auditor’s knowledge about the presence or absence of control activities obtained

from the understanding of the other components of internal control assists the auditor

in determining whether it is necessary to devote additional attention to obtaining an

understanding of control activities.

Considerations Specific to Smaller Entities

A101. The concepts underlying control activities in small entities are likely to be similar to

those in larger entities, but the formality with which they operate may vary. Further,

small entities may find that certain types of control activities are not relevant because

of controls applied by management. For example, management’s sole authority for

granting credit to customers and approving significant purchases can provide strong

control over important account balances and transactions, lessening or removing the

need for more detailed control activities.

A102. Control activities relevant to the audit of a smaller entity are likely to relate to the

main transaction cycles such as revenues, purchases and employment expenses.

Risks Arising from IT (Ref: Para. 21)

A103. The use of IT affects the way that control activities are implemented. From the

auditor’s perspective, controls over IT systems are effective when they maintain the

integrity of information and the security of the data such systems process, and

include effective general IT controls and application controls.

A104. General IT controls are policies and procedures that relate to many applications and

support the effective functioning of application controls. They apply to mainframe,

miniframe, and end-user environments. General IT controls that maintain the integrity

of information and security of data commonly include controls over the following:

Data center and network operations.

System software acquisition, change and maintenance.

Program change.

Access security.

Application system acquisition, development, and maintenance.

They are generally implemented to deal with the risks referred to in paragraph A63

above.

A105. Application controls are manual or automated procedures that typically operate at a

business process level and apply to the processing of transactions by individual

ISA (Ireland) 315

31

applications. Application controls can be preventive or detective in nature and are

designed to ensure the integrity of the accounting records. Accordingly, application

controls relate to procedures used to initiate, record, process and report transactions

or other financial data. These controls help ensure that transactions occurred, are

authorized, and are completely and accurately recorded and processed. Examples

include edit checks of input data, and numerical sequence checks with manual

follow-up of exception reports or correction at the point of data entry.

Components of Internal Control—Monitoring of Controls (Ref: Para. 22)

A106. Monitoring of controls is a process to assess the effectiveness of internal control

performance over time. It involves assessing the effectiveness of controls on a timely

basis and taking necessary remedial actions. Management accomplishes monitoring

of controls through ongoing activities, separate evaluations, or a combination of the

two. Ongoing monitoring activities are often built into the normal recurring activities of

an entity and include regular management and supervisory activities.

A107. Management’s monitoring activities may include using information from

communications from external parties such as customer complaints and regulator

comments that may indicate problems or highlight areas in need of improvement.

Considerations Specific to Smaller Entities

A108. Management’s monitoring of control is often accomplished by management’s or the

owner-manager’s close involvement in operations. This involvement often will identify

significant variances from expectations and inaccuracies in financial data leading to

remedial action to the control.

The Entity’s Internal Audit Function (Ref: Para. 23)

A109. If the entity has an internal audit function, obtaining an understanding of that function

contributes to the auditor’s understanding of the entity and its environment, including

internal control, in particular the role that the function plays in the entity’s monitoring

of internal control over financial reporting. This understanding, together with the

information obtained from the auditor’s inquiries in paragraph 6(a) of this ISA

(Ireland), may also provide information that is directly relevant to the auditor’s

identification and assessment of the risks of material misstatement.

A110. The objectives and scope of an internal audit function, the nature of its

responsibilities and its status within the organization, including the function’s authority

and accountability, vary widely and depend on the size and structure of the entity and

the requirements of management and, where applicable, those charged with

governance. These matters may be set out in an internal audit charter or terms of

reference.

A111. The responsibilities of an internal audit function may include performing procedures

and evaluating the results to provide assurance to management and those charged

with governance regarding the design and effectiveness of risk management, internal

control and governance processes. If so, the internal audit function may play an

important role in the entity’s monitoring of internal control over financial reporting.

However, the responsibilities of the internal audit function may be focused on

evaluating the economy, efficiency and effectiveness of operations and, if so, the

work of the function may not directly relate to the entity’s financial reporting.

ISA (Ireland) 315

32

A112. The auditor’s inquiries of appropriate individuals within the internal audit function in

accordance with paragraph 6(a) of this ISA (Ireland) help the auditor obtain an

understanding of the nature of the internal audit function’s responsibilities. If the

auditor determines that the function’s responsibilities are related to the entity’s

financial reporting, the auditor may obtain further understanding of the activities

performed, or to be performed, by the internal audit function by reviewing the internal

audit function’s audit plan for the period, if any, and discussing that plan with the

appropriate individuals within the function.

A113. If the nature of the internal audit function’s responsibilities and assurance activities

are related to the entity’s financial reporting, the auditor may also be able to use the

work of the internal audit function to modify the nature or timing, or reduce the extent,

of audit procedures to be performed directly by the auditor in obtaining audit

evidence. Auditors may be more likely to be able to use the work of an entity’s

internal audit function when it appears, for example, based on experience in previous

audits or the auditor’s risk assessment procedures, that the entity has an internal

audit function that is adequately and appropriately resourced relative to the size of

the entity and the nature of its operations, and has a direct reporting relationship to

those charged with governance.

A114. If, based on the auditor’s preliminary understanding of the internal audit function, the

auditor expects to use the work of the internal audit function to modify the nature or

timing, or reduce the extent, of audit procedures to be performed, ISA (Ireland) 610

applies.

A115. As is further discussed in ISA (Ireland) 610, the activities of an internal audit function

are distinct from other monitoring controls that may be relevant to financial reporting,

such as reviews of management accounting information that are designed to

contribute to how the entity prevents or detects misstatements.

A116. Establishing communications with the appropriate individuals within an entity’s

internal audit function early in the engagement, and maintaining such

communications throughout the engagement, can facilitate effective sharing of

information. It creates an environment in which the auditor can be informed of

significant matters that may come to the attention of the internal audit function when

such matters may affect the work of the auditor. ISA (Ireland) 200 discusses the

importance of the auditor planning and performing the audit with professional

skepticism, including being alert to information that brings into question the reliability

of documents and responses to inquiries to be used as audit evidence. Accordingly,

communication with the internal audit function throughout the engagement may

provide opportunities for internal auditors to bring such information to the auditor’s

attention. The auditor is then able to take such information into account in the

auditor’s identification and assessment of risks of material misstatement.

Sources of Information (Ref: Para. 24)

A117. Much of the information used in monitoring may be produced by the entity’s

information system. If management assumes that data used for monitoring are

accurate without having a basis for that assumption, errors that may exist in the

information could potentially lead management to incorrect conclusions from its

monitoring activities. Accordingly, an understanding of:

the sources of the information related to the entity’s monitoring activities; and

ISA (Ireland) 315

33

the basis upon which management considers the information to be sufficiently

reliable for the purpose,

is required as part of the auditor’s understanding of the entity’s monitoring activities

as a component of internal control.

Identifying and Assessing the Risks of Material Misstatement

Assessment of Risks of Material Misstatement at the Financial Statement Level (Ref: Para. 25

(a))

A118. Risks of material misstatement at the financial statement level refer to risks that

relate pervasively to the financial statements as a whole and potentially affect many

assertions. Risks of this nature are not necessarily risks identifiable with specific

assertions at the class of transactions, account balance, or disclosure level. Rather,

they represent circumstances that may increase the risks of material misstatement at

the assertion level, for example, through management override of internal control.

Financial statement level risks may be especially relevant to the auditor’s

consideration of the risks of material misstatement arising from fraud.

A119. Risks at the financial statement level may derive in particular from a deficient control

environment (although these risks may also relate to other factors, such as declining

economic conditions). For example, deficiencies such as a lack of management

competence or lack of oversight over the preparation of the financial statements may

have a more pervasive effect on the financial statements and may require an overall

response by the auditor.

A120. The auditor’s understanding of internal control may raise doubts about the auditability

of an entity’s financial statements. For example:

Concerns about the integrity of the entity’s management may be so serious as

to cause the auditor to conclude that the risk of management misrepresentation

in the financial statements is such that an audit cannot be conducted.

Concerns about the condition and reliability of an entity’s records may cause

the auditor to conclude that it is unlikely that sufficient appropriate audit

evidence will be available to support an unmodified opinion on the financial

statements.

A121. ISA (Ireland) 70516 establishes requirements and provides guidance in determining

whether there is a need for the auditor to express a qualified opinion or disclaim an

opinion or, as may be required in some cases, to withdraw from the engagement

where withdrawal is possible under applicable law or regulation.

Assessment of Risks of Material Misstatement at the Assertion Level (Ref: Para. 25(b))

A122. Risks of material misstatement at the assertion level for classes of transactions,

account balances, and disclosures need to be considered because such

consideration directly assists in determining the nature, timing, and extent of further

audit procedures at the assertion level necessary to obtain sufficient appropriate

audit evidence. In identifying and assessing risks of material misstatement at the

assertion level, the auditor may conclude that the identified risks relate more

pervasively to the financial statements as a whole and potentially affect many

assertions.

16

ISA (Ireland) 705, Modifications to the Opinion in the Independent Auditor’s Report.

ISA (Ireland) 315

34

The Use of Assertions

A123. In representing that the financial statements are in accordance with the applicable

financial reporting framework, management1a implicitly or explicitly makes assertions

regarding recognition, measurement and presentation of classes of transactions and

events, account balances and disclosures.

A123a. The auditor may use the assertions as described in paragraph A124 (a)-(b) below or

may express them differently provided all aspects described below have been

covered. For example, the auditor may choose to combine the assertions about

classes of transactions and events, and related disclosures, with the assertions about

account balances, and related disclosures.

Assertions about classes of transaction, account balances, and related disclosures

A124. Assertions used by the auditor in considering the different types of potential

misstatements that may occur may fall into the following categories:

(a) Assertions about classes of transactions and events, and related disclosures,

for the period under audit:

(i) Occurrence—transactions and events that have been recorded or

disclosed, have occurred, and such transactions and events pertain to the

entity.

(ii) Completeness—all transactions and events that should have been

recorded have been recorded, and all related disclosures that should

have been included in the financial statements have been included.

(iii) Accuracy—amounts and other data relating to recorded transactions and

events have been recorded appropriately, and related disclosures have

been appropriately measured and described.

(iv) Cutoff—transactions and events have been recorded in the correct

accounting period.

(v) Classification—transactions and events have been recorded in the proper

accounts.

(vi) Presentation—transactions and events are appropriately aggregated or

disaggregated and clearly described, and related disclosures are relevant

and understandable in the context of the requirements of the applicable

financial reporting framework.

(b) Assertions about account balances, and related disclosures, at the period end:

(i) Existence—assets, liabilities, and equity interests exist.

(ii) Rights and obligations—the entity holds or controls the rights to assets,

and liabilities are the obligations of the entity.

(iii) Completeness—all assets, liabilities and equity interests that should have

been recorded have been recorded, and all related disclosures that

should have been included in the financial statements have been

included.

(iv) Accuracy, valuation and allocation—assets, liabilities, and equity interests

have been included in the financial statements at appropriate amounts

and any resulting valuation or allocation adjustments have been

ISA (Ireland) 315

35

appropriately recorded, and related disclosures have been appropriately

measured and described.

(v) Classification— assets, liabilities, and equity interests have been recorded

in the proper accounts.

(vi) Presentation— assets, liabilities, and equity interests are appropriately

aggregated or disaggregated and clearly described, and related

disclosures are relevant and understandable in the context of the

requirements of the applicable financial reporting framework.

Assertions about other disclosures

A124a.The assertions described in paragraph A124(a)-(b) above, adapted as appropriate,

may also be used by the auditor in considering the different types of potential

misstatements that may occur in disclosures not directly related to recorded classes

of transactions, events, or account balances. As an example of such a disclosure, the

entity may be required to describe its exposure to risks arising from financial

instruments, including how the risks arise; the objectives, policies and processes for

managing the risks; and the methods used to measure the risks.

Considerations specific to public sector entities

A126. When making assertions about the financial statements of public sector entities, in

addition to those assertions set out in paragraph A124, management1a may often

assert that transactions and events have been carried out in accordance with law,

regulation or other authority. Such assertions may fall within the scope of the financial

statement audit.

Process of Identifying Risks of Material Misstatement (Ref: Para. 26(a))

A127. Information gathered by performing risk assessment procedures, including the audit

evidence obtained in evaluating the design of controls and determining whether they

have been implemented, is used as audit evidence to support the risk assessment.

The risk assessment determines the nature, timing, and extent of further audit

procedures to be performed. In identifying the risks of material misstatement in the

financial statements, the auditor exercise professional skepticism in accordance with

ISA (Ireland) 200.17

A128. Appendix 2 provides examples of conditions and events that may indicate the

existence of risks of material misstatement, including risks of material misstatement

relating to disclosures.

A128a. As explained in ISA (Ireland) 320,18 materiality and audit risk are considered when

identifying and assessing the risks of material misstatement in classes of

transactions, account balances and disclosures. The auditor’s determination of

materiality is a matter of professional judgment, and is affected by the auditor’s

perception of the financial reporting needs of users of the financial statements.19

A128b. The auditor’s consideration of disclosures in the financial statements when identifying

risks includes quantitative and qualitative disclosures, the misstatement of which

17

ISA (Ireland) 200, Overall Objectives of the Independent Auditor and the Conduct of an Audit in

Accordance with International Standards on Auditing (Ireland), paragraph 15. 18

ISA (Ireland) 320, Materiality in Planning and Performing an Audit, paragraph A1. 19

ISA (Ireland) 320, paragraph 4.

ISA (Ireland) 315

36

could be material (i.e., in general, misstatements are considered to be material if they

could reasonably be expected to influence the economic decisions of users taken on

the basis of the financial statements as a whole). Depending on the circumstances of

the entity and the engagement, examples of disclosures that will have qualitative

aspects and that may be relevant when assessing the risks of material misstatement

include disclosures about:

Liquidity and debt covenants of an entity in financial distress.

Events or circumstances that have led to the recognition of an impairment loss.

Key sources of estimation uncertainty, including assumptions about the future.

The nature of a change in accounting policy, and other relevant disclosures

required by the applicable financial reporting framework, where, for example,

new financial reporting requirements are expected to have a significant impact

on the financial position and financial performance of the entity.

Share-based payment arrangements, including information about how any

amounts recognized were determined, and other relevant disclosures.

Related parties, and related party transactions.

Sensitivity analysis, including the effects of changes in assumptions used in the

entity’s valuation techniques intended to enable users to understand the

underlying measurement uncertainty of a recorded or disclosed amount.

Considerations specific to smaller entities

A128c. Disclosures in the financial statements of smaller entities may be less detailed or less

complex (e.g., some financial reporting frameworks allow smaller entities to provide

fewer disclosures in the financial statements). However, this does not relieve the

auditor of the responsibility to obtain an understanding of the entity and its

environment, including internal control, as it relates to disclosures.

Relating Controls to Assertions (Ref: Para. 26(c))

A129. In making risk assessments, the auditor may identify the controls that are likely to

prevent, or detect and correct, material misstatement in specific assertions.

Generally, it is useful to obtain an understanding of controls and relate them to

assertions in the context of processes and systems in which they exist because

individual control activities often do not in themselves address a risk. Often, only

multiple control activities, together with other components of internal control, will be

sufficient to address a risk.

A130. Conversely, some control activities may have a specific effect on an individual

assertion embodied in a particular class of transactions or account balance. For

example, the control activities that an entity established to ensure that its personnel

are properly counting and recording the annual physical inventory relate directly to

the existence and completeness assertions for the inventory account balance.

A131. Controls can be either directly or indirectly related to an assertion. The more indirect

the relationship, the less effective that control may be in preventing, or detecting and

correcting, misstatements in that assertion. For example, a sales manager’s review

of a summary of sales activity for specific stores by region ordinarily is only indirectly

related to the completeness assertion for sales revenue. Accordingly, it may be less

ISA (Ireland) 315

37

effective in reducing risk for that assertion than controls more directly related to that

assertion, such as matching shipping documents with billing documents.

Material Misstatements

A131a. Potential misstatements in individual statements and disclosures may be judged to

be material due to size, nature or circumstances. (Ref: Para. 26(d))

Significant Risks

Identifying Significant Risks (Ref: Para. 28)

A132. Significant risks often relate to significant non-routine transactions or judgmental

matters. Non-routine transactions are transactions that are unusual, due to either

size or nature, and that therefore occur infrequently. Judgmental matters may include

the development of accounting estimates for which there is significant measurement

uncertainty. Routine, non-complex transactions that are subject to systematic

processing are less likely to give rise to significant risks.

A133. Risks of material misstatement may be greater for significant non-routine

transactions arising from matters such as the following:

Greater management intervention to specify the accounting treatment.

Greater manual intervention for data collection and processing.

Complex calculations or accounting principles.

The nature of non-routine transactions, which may make it difficult for the entity

to implement effective controls over the risks.

A134. Risks of material misstatement may be greater for significant judgmental matters that

require the development of accounting estimates, arising from matters such as the

following:

Accounting principles for accounting estimates or revenue recognition may be

subject to differing interpretation.

Required judgment may be subjective or complex, or require assumptions

about the effects of future events, for example, judgment about fair value.

A135. ISA (Ireland) 330 describes the consequences for further audit procedures of

identifying a risk as significant.20

Significant risks relating to the risks of material misstatement due to fraud

A136. ISA (Ireland) 240 provides further requirements and guidance in relation to the

identification and assessment of the risks of material misstatement due to fraud.21

Understanding Controls Related to Significant Risks (Ref: Para. 29)

A137. Although risks relating to significant non-routine or judgmental matters are often less

likely to be subject to routine controls, management may have other responses

intended to deal with such risks. Accordingly, the auditor’s understanding of whether

the entity has designed and implemented controls for significant risks arising from

non-routine or judgmental matters includes whether and how management responds

to the risks. Such responses might include:

20

ISA (Ireland) 330, paragraphs 15 and 21. 21

ISA (Ireland) 240, paragraphs 25-27.

ISA (Ireland) 315

38

Control activities such as a review of assumptions by senior management or

experts.

Documented processes for estimations.

Approval by those charged with governance.

A138. For example, where there are one-off events such as the receipt of notice of a

significant lawsuit, consideration of the entity’s response may include such matters

as whether it has been referred to appropriate experts (such as internal or external

legal counsel), whether an assessment has been made of the potential effect, and

how it is proposed that the circumstances are to be disclosed in the financial

statements.

A139. In some cases, management may not have appropriately responded to significant

risks of material misstatement by implementing controls over these significant risks.

Failure by management to implement such controls is an indicator of a significant

deficiency in internal control.22Risks for Which Substantive Procedures Alone Do Not

Provide Sufficient Appropriate Audit Evidence (Ref: Para. 30)

A140. Risks of material misstatement may relate directly to the recording of routine classes

of transactions or account balances, and the preparation of reliable financial

statements. Such risks may include risks of inaccurate or incomplete processing for

routine and significant classes of transactions such as an entity’s revenue,

purchases, and cash receipts or cash payments.

A141. Where such routine business transactions are subject to highly automated

processing with little or no manual intervention, it may not be possible to perform only

substantive procedures in relation to the risk. For example, the auditor may consider

this to be the case in circumstances where a significant amount of an entity’s

information is initiated, recorded, processed, or reported only in electronic form such

as in an integrated system. In such cases:

Audit evidence may be available only in electronic form, and its sufficiency and

appropriateness usually depend on the effectiveness of controls over its

accuracy and completeness.

The potential for improper initiation or alteration of information to occur and not

be detected may be greater if appropriate controls are not operating effectively.

A142. The consequences for further audit procedures of identifying such risks are described

in ISA (Ireland) 330.23

Revision of Risk Assessment (Ref: Para. 31)

A143. During the audit, information may come to the auditor’s attention that differs

significantly from the information on which the risk assessment was based. For

example, the risk assessment may be based on an expectation that certain controls

are operating effectively. In performing tests of those controls, the auditor may obtain

audit evidence that they were not operating effectively at relevant times during the

audit. Similarly, in performing substantive procedures the auditor may detect

misstatements in amounts or frequency greater than is consistent with the auditor’s

22

ISA (Ireland) 265, Communicating Deficiencies in Internal Control to Those Charged with

Governance and Management, paragraph A7. 23

ISA (Ireland) 330, paragraph 8.

ISA (Ireland) 315

39

risk assessments. In such circumstances, the risk assessment may not appropriately

reflect the true circumstances of the entity and the further planned audit procedures

may not be effective in detecting material misstatements. See ISA (Ireland) 330 for

further guidance.

Documentation (Ref: Para. 32)

A144. The manner in which the requirements of paragraph 32 are documented is for the

auditor to determine using professional judgment. For example, in audits of small

entities the documentation may be incorporated in the auditor’s documentation of the

overall strategy and audit plan.24 Similarly, for example, the results of the risk

assessment may be documented separately, or may be documented as part of the

auditor’s documentation of further procedures.25 The form and extent of the

documentation is influenced by the nature, size and complexity of the entity and its

internal control, availability of information from the entity and the audit methodology

and technology used in the course of the audit.

A145. For entities that have uncomplicated businesses and processes relevant to financial

reporting, the documentation may be simple in form and relatively brief. It is not

necessary to document the entirety of the auditor’s understanding of the entity and

matters related to it. Key elements of understanding documented by the auditor

include those on which the auditor based the assessment of the risks of material

misstatement.

A146. The extent of documentation may also reflect the experience and capabilities of the

members of the audit engagement team. Provided the requirements of ISA (Ireland)

230 are always met, an audit undertaken by an engagement team comprising less

experienced individuals may require more detailed documentation to assist them to

obtain an appropriate understanding of the entity than one that includes experienced

individuals.

A147. For recurring audits, certain documentation may be carried forward, updated as

necessary to reflect changes in the entity’s business or processes.

24

ISA (Ireland) 300, Planning an Audit of Financial Statements, paragraphs 7 and 9. 25

ISA (Ireland) 330, paragraph 28.

ISA (Ireland) 315

40

Appendix 1

(Ref: Paras. 4(c), 14-24, A76-A117)

Internal Control Components

1. This appendix further explains the components of internal control, as set out in

paragraphs 4(c), 14-24 and A76-A117, as they relate to a financial statement audit.

Control Environment

2. The control environment encompasses the following elements:

(a) Communication and enforcement of integrity and ethical values. The

effectiveness of controls cannot rise above the integrity and ethical values of

the people who create, administer, and monitor them. Integrity and ethical

behavior are the product of the entity’s ethical and behavioral standards, how

they are communicated, and how they are reinforced in practice. The

enforcement of integrity and ethical values includes, for example, management

actions to eliminate or mitigate incentives or temptations that might prompt

personnel to engage in dishonest, illegal, or unethical acts. The communication

of entity policies on integrity and ethical values may include the communication

of behavioral standards to personnel through policy statements and codes of

conduct and by example.

(b) Commitment to competence. Competence is the knowledge and skills

necessary to accomplish tasks that define the individual’s job.

(c) Participation by those charged with governance. An entity’s control

consciousness is influenced significantly by those charged with governance.

The importance of the responsibilities of those charged with governance is

recognized in codes of practice and other laws and regulations or guidance

produced for the benefit of those charged with governance. Other

responsibilities of those charged with governance include oversight of the

design and effective operation of whistle blower procedures and the process for

reviewing the effectiveness of the entity’s internal control.

(d) Management’s philosophy and operating style. Management’s philosophy and

operating style encompass a broad range of characteristics. For example,

management’s attitudes and actions toward financial reporting may manifest

themselves through conservative or aggressive selection from available

alternative accounting principles, or conscientiousness and conservatism with

which accounting estimates are developed.

(e) Organizational structure. Establishing a relevant organizational structure

includes considering key areas of authority and responsibility and appropriate

lines of reporting. The appropriateness of an entity’s organizational structure

depends, in part, on its size and the nature of its activities.

(f) Assignment of authority and responsibility. The assignment of authority and

responsibility may include policies relating to appropriate business practices,

knowledge and experience of key personnel, and resources provided for

carrying out duties. In addition, it may include policies and communications

directed at ensuring that all personnel understand the entity’s objectives, know

ISA (Ireland) 315

41

how their individual actions interrelate and contribute to those objectives, and

recognize how and for what they will be held accountable.

(g) Human resource policies and practices. Human resource policies and practices

often demonstrate important matters in relation to the control consciousness of

an entity. For example, standards for recruiting the most qualified individuals –

with emphasis on educational background, prior work experience, past

accomplishments, and evidence of integrity and ethical behavior – demonstrate

an entity’s commitment to competent and trustworthy people. Training policies

that communicate prospective roles and responsibilities and include practices

such as training schools and seminars illustrate expected levels of performance

and behavior. Promotions driven by periodic performance appraisals

demonstrate the entity’s commitment to the advancement of qualified personnel

to higher levels of responsibility.

Entity’s Risk Assessment Process

3. For financial reporting purposes, the entity’s risk assessment process includes how

management identifies business risks relevant to the preparation of financial

statements in accordance with the entity’s applicable financial reporting framework,

estimates their significance, assesses the likelihood of their occurrence, and decides

upon actions to respond to and manage them and the results thereof. For example,

the entity’s risk assessment process may address how the entity considers the

possibility of unrecorded transactions or identifies and analyzes significant estimates

recorded in the financial statements.

4. Risks relevant to reliable financial reporting include external and internal events,

transactions or circumstances that may occur and adversely affect an entity’s ability

to initiate, record, process, and report financial data consistent with the assertions of

management1a in the financial statements. Management may initiate plans, programs,

or actions to address specific risks or it may decide to accept a risk because of cost

or other considerations. Risks can arise or change due to circumstances such as the

following:

Changes in operating environment. Changes in the regulatory or operating

environment can result in changes in competitive pressures and significantly

different risks.

New personnel. New personnel may have a different focus on or understanding

of internal control.

New or revamped information systems. Significant and rapid changes in

information systems can change the risk relating to internal control.

Rapid growth. Significant and rapid expansion of operations can strain controls

and increase the risk of a breakdown in controls.

New technology. Incorporating new technologies into production processes or

information systems may change the risk associated with internal control.

New business models, products, or activities. Entering into business areas or

transactions with which an entity has little experience may introduce new risks

associated with internal control.

ISA (Ireland) 315

42

Corporate restructurings. Restructurings may be accompanied by staff

reductions and changes in supervision and segregation of duties that may

change the risk associated with internal control.

Expanded foreign operations. The expansion or acquisition of foreign

operations carries new and often unique risks that may affect internal control,

for example, additional or changed risks from foreign currency transactions.

New accounting pronouncements. Adoption of new accounting principles or

changing accounting principles may affect risks in preparing financial

statements.

Information System, Including the Related Business Processes, Relevant to Financial

Reporting, and Communication

5. An information system consists of infrastructure (physical and hardware

components), software, people, procedures, and data. Many information systems

make extensive use of information technology (IT).

6. The information system relevant to financial reporting objectives, which includes the

financial reporting system, encompasses methods and records that:

Identify and record all valid transactions.

Describe on a timely basis the transactions in sufficient detail to permit proper

classification of transactions for financial reporting.

Measure the value of transactions in a manner that permits recording their

proper monetary value in the financial statements.

Determine the time period in which transactions occurred to permit recording of

transactions in the proper accounting period.

Present properly the transactions and related disclosures in the financial

statements.

7. The quality of system-generated information affects management’s ability to make

appropriate decisions in managing and controlling the entity’s activities and to

prepare reliable financial reports.

8. Communication, which involves providing an understanding of individual roles and

responsibilities pertaining to internal control over financial reporting, may take such

forms as policy manuals, accounting and financial reporting manuals, and

memoranda. Communication also can be made electronically, orally, and through the

actions of management.

Control Activities

9. Generally, control activities that may be relevant to an audit may be categorized as

policies and procedures that pertain to the following:

Performance reviews. These control activities include reviews and analyses of

actual performance versus budgets, forecasts, and prior period performance;

relating different sets of data – operating or financial – to one another, together

with analyses of the relationships and investigative and corrective actions;

comparing internal data with external sources of information; and review of

functional or activity performance.

ISA (Ireland) 315

43

Information processing. The two broad groupings of information systems

control activities are application controls, which apply to the processing of

individual applications, and general IT controls, which are policies and

procedures that relate to many applications and support the effective

functioning of application controls by helping to ensure the continued proper

operation of information systems. Examples of application controls include

checking the arithmetical accuracy of records, maintaining and reviewing

accounts and trial balances, automated controls such as edit checks of input

data and numerical sequence checks, and manual follow-up of exception

reports. Examples of general IT controls are program change controls, controls

that restrict access to programs or data, controls over the implementation of

new releases of packaged software applications, and controls over system

software that restrict access to or monitor the use of system utilities that could

change financial data or records without leaving an audit trail.

Physical controls. Controls that encompass:

○ The physical security of assets, including adequate safeguards such as

secured facilities over access to assets and records.

○ The authorization for access to computer programs and data files.

○ The periodic counting and comparison with amounts shown on control

records (for example, comparing the results of cash, security and

inventory counts with accounting records).

The extent to which physical controls intended to prevent theft of assets are

relevant to the reliability of financial statement preparation, and therefore the

audit, depends on circumstances such as when assets are highly susceptible to

misappropriation.

Segregation of duties. Assigning different people the responsibilities of

authorizing transactions, recording transactions, and maintaining custody of

assets. Segregation of duties is intended to reduce the opportunities to allow

any person to be in a position to both perpetrate and conceal errors or fraud in

the normal course of the person’s duties.

10. Certain control activities may depend on the existence of appropriate higher level

policies established by management or those charged with governance. For example,

authorization controls may be delegated under established guidelines, such as

investment criteria set by those charged with governance; alternatively, non-routine

transactions such as major acquisitions or divestments may require specific high level

approval, including in some cases that of shareholders.

Monitoring of Controls

11. An important management responsibility is to establish and maintain internal control

on an ongoing basis. Management’s monitoring of controls includes considering

whether they are operating as intended and that they are modified as appropriate for

changes in conditions. Monitoring of controls may include activities such as

management’s review of whether bank reconciliations are being prepared on a timely

basis, internal auditors’ evaluation of sales personnel’s compliance with the entity’s

policies on terms of sales contracts, and a legal department’s oversight of compliance

ISA (Ireland) 315

44

with the entity’s ethical or business practice policies. Monitoring is done also to

ensure that controls continue to operate effectively over time. For example, if the

timeliness and accuracy of bank reconciliations are not monitored, personnel are

likely to stop preparing them.

12. Internal auditors or personnel performing similar functions may contribute to the

monitoring of an entity’s controls through separate evaluations. Ordinarily, they

regularly provide information about the functioning of internal control, focusing

considerable attention on evaluating the effectiveness of internal control, and

communicate information about strengths and deficiencies in internal control and

recommendations for improving internal control.

13. Monitoring activities may include using information from communications from

external parties that may indicate problems or highlight areas in need of

improvement. Customers implicitly corroborate billing data by paying their invoices or

complaining about their charges. In addition, regulators may communicate with the

entity concerning matters that affect the functioning of internal control, for example,

communications concerning examinations by bank regulatory agencies. Also,

management may consider communications relating to internal control from external

auditors in performing monitoring activities.

ISA (Ireland) 315

45

Appendix 2

(Ref: Para. A40, A128)

Conditions and Events That May Indicate Risks of Material Misstatement

The following are examples of conditions and events that may indicate the existence of risks

of material misstatement in the financial statements. The examples provided cover a broad

range of conditions and events; however, not all conditions and events are relevant to every

audit engagement and the list of examples is not necessarily complete.

Operations in regions that are economically unstable, for example, countries with

significant currency devaluation or highly inflationary economies.

Operations exposed to volatile markets, for example, futures trading.

Operations that are subject to a high degree of complex regulation.

Going concern and liquidity issues including loss of significant customers.

Constraints on the availability of capital and credit.

Changes in the industry in which the entity operates.

Changes in the supply chain.

Developing or offering new products or services, or moving into new lines of business.

Expanding into new locations.

Changes in the entity such as large acquisitions or reorganizations or other unusual

events.

Entities or business segments likely to be sold.

The existence of complex alliances and joint ventures.

Use of off balance sheet finance, special-purpose entities, and other complex financing

arrangements.

Significant transactions with related parties.

Lack of personnel with appropriate accounting and financial reporting skills.

Changes in key personnel including departure of key executives.

Deficiencies in internal control, especially those not addressed by management.

Incentives for management and employees to engage in fraudulent financial reporting.

Inconsistencies between the entity’s IT strategy and its business strategies.

Changes in the IT environment.

Installation of significant new IT systems related to financial reporting.

Inquiries into the entity’s operations or financial results by regulatory or government

bodies.

Past misstatements, history of errors or a significant amount of adjustments at period

end.

ISA (Ireland) 315

46

Significant amount of non-routine or non-systematic transactions including

intercompany transactions and large revenue transactions at period end.

Transactions that are recorded based on management’s intent, for example, debt

refinancing, assets to be sold and classification of marketable securities.

Application of new accounting pronouncements.

Accounting measurements that involve complex processes.

Events or transactions that involve significant measurement uncertainty, including

accounting estimates, and related disclosures.

Omission, or obscuring, of significant information in disclosures.

Pending litigation and contingent liabilities, for example, sales warranties, financial

guarantees and environmental remediation.